Wednesday, November 11, 2015

Debt: The Developed World Has Lost Touch With Economic Reality

The Debt Timebomb

When I noticed a headline 0ver a story on the Zero Hedge financial website which proclaimed the US National Debt is three times higher than the published figure it attracted my attention not because this was news to me. If we are talking about Sovereign debt (the amount the government owes) then the figure 0f $65 trillion seems reasonable; the $18trillion figure usually quoted is 'The National Debt' the total of treasury bonds held by US citizens and businesses. And the total debt, when we bear in mind that the USA is a federation of fifty states, is several times higher than that, although estimated figures vary wildly.

Dave Walker, head of the Government Accountability Office (GAO) under Presidents Clinton and George W. Bush, said, "If you add to that $18.5 trillion the unfunded civilian and military pensions and retiree healthcare, the additional underfunding for Social Security, the additional underfunding for Medicare, various commitments and contingencies that the federal government has, the real number is about $65 trillion rather than $18 trillion, and it’s growing exponentially as spending continues to outstrip revenue, adding to the interest liability on debts."

The former comptroller general, whose job is to ensure government spending is fiscally responsible, said the groing debt burdennational hampers the ability of government to carry out domestic and foreign policy obligations.

"If you don’t keep your economy strong, and that means to be able to generate more jobs and opportunities, you’re not going to be strong internationally with regard to foreign policy, you’re not going to be able to invest what you need to invest in national defense and homeland security, and ultimately you’re not going to be able to provide the kind of social safety net that we need in this country," he said.

Walker concluded that the American government have lost touch with reality when it comes to spending and called for Democrats and Republicans to put aside partisan politics to come together to fix the problem.

but the USA is not alone is suffering from a mounting, and unsustainable debt burden, the problem is endemic throughout the developed world not from political malfeasance which, by masking the problem rather than tackling it only serves to make the consequences worse.

UK's Real Debt
The Institute of Economic Affairs (IEA) has calculated that the UK national debt is £4.8 trillion once state and public sector pension liabilities are included, or £78,000 for every person in the UK. Given that UK bonds have a coupon value (nominal interest rate) of 3.5% that means the government is paying £2780 (more than £50 a week for each of us)

The IEA raised its concerns, and called on the government to reveal the true debt level after the latest public finance data from the Office for National Statistics (ONS) showed that the total debt, excluding bank bail-outs, is £816bn – itself a record high. However, these figures do not include the state's pension liabilities which contravention standard accounting practices.

IEA's director-general Mark Littlewood said: "The latest official national debt figure is seriously misleading. Looming in the background are pension liabilities. These should be moved to the forefront.

"The ONS should include these liabilities in their calculations. It is shocking enough to see official figures revealing a jump in national debt over the last year from the equivalent of 48pc of GDP to 56pc, but the grave reality is that our real national debt stands at 333pc of GDP."

IEA research fellow Nick Silver said the full figure, including the £1.2 trillion public sector pension liability and £2.7 trillion state pension liability, should be published either monthly or annually alongside the net debt data for reasons of transparency.

The ONS began publishing the full list of Britain's debts and liabilities in July this year.

Aileen Simkins, ONS director of operations on economic statistics, said the figures would be updated in September and that the ONS plans to compile and release them on an annual basis "to begin with".

In common with most European nations and the USA, the UK government has become adept at disguising important economic figures, although the task of making the economic data from the developed world look positive is akin to polishing a turd, the true depth of the disaster caused by mismanagement of financial systems because of pressure from the politically correct left has so far been masked sufficiently to maintain the status quo in politics.

France is in free fall

The euro zone’s second-largest economy is suffering more than any other member except for Greece from a shocking deterioration in competitiveness. And rather than acting to stop it, France's socialist government are admitting multitudes of unemployable, illiterate immigrants and paying them welfare benefits, implementing more and more restrictive labour laws, raising taxes (and especially tax on business profits) ever higher and doing the exact opposite of what is needed to turn around their country's economic decline.

Surprisingly, the yield on France’s ten-year government bonds stands at just 2%, just a few ticks above Germany’s (yield is the real interest rate on bonds rather than the 'coupon value' mentioned elsewhere). Such headline numbers suggest France is not in nearly as much trouble as the derisively titled "PIIGS" debtor nations, Portugal, Ireland, Italy, Greece and Spain. So far, the trajectory of its debts and deficits isn’t as distressing as the figures for the PIIGs, or even the U.K. and the U.S.

That investor confidence stems, however, from France's assumed parity with Germany in the European integration project. As the EU nations move towards 'ever closer integration' the bankers reason, the German economic miracle will prop up the more developed economies in the Euozone.

France’s role in creating the euro and long term committment to uniting EU member stated into a single political entity enhances its aura of solidity. It was Socialist French President Francois Mitterrand who in 1989 persuaded Chancellor Helmut Kohl to back monetary union in exchange for France’s support for German reunification. In fact, France and Germany, along with the Netherlands, dramatized their commitment by effectively uniting the Franc and Deutschemark in a currency union that held their exchange rates in a narrow band, and heralded the euro’s birth in 1999. In the boom years of the mid-2000s, France virtually matched Germany as the twin growth engine of the thriving, 17-nation eurozone.

A deeper look shows that France is stuck in a perpetual economic crisis. Due to an unafforable welfare bill caused by mass immigration, offshoring of jobs and an ageing population, the french economy cannot meet its oblicagtios AND service its debts. The eurozone’s second-largest economy (2012 GDP: 2 trillion euros) is suffering more than any other member from a shocking deterioration in competitiveness. Put simply, France’s products — its cars, steel, clothing, electronics — for reasons mentioned above cost far too much to produce compared with competing goods both from Asia and its European neighbors, including not just Germany but even Spain and Italy.

Like most nations, the Greek government relies on borrowed money to balance its books. Most developed nations have been relying on borrowing to even out the bumps of the global downturn and using public spending to keep unemployment levels manageable. The recession made things harder to manage because tax revenues started falling just as welfare payments to unemployed people started to rise. It doesn't help that tax evasion is the cultural norm in Greece and pension rights are unusually generous.

Unfortunately, investors have lost confidence in the Greek political establishment so they have been demanding ever higher rates of interest to compensate for the risk that they might not get their money back. The higher its borrowing costs, the harder it is for the Greek economy to grow itself out of trouble.

Events began to spiral out of control when credit rating agencies downgraded Greek government debt to "junk" status, pushing the cost of borrowing so high that the country in effect had its credit cards cancelled, because it could not pay the monthly interest due on existing debt. That put the Greek government in the position of being unable to meet obligations such as wages and pensions because it could not sell bonds to fund its day to day activities. Fearing default (bankruptcy), Greece had to turn instead to the European Union and the International Monetary Fund (IMF) – the world's lender of last resort – for 120bn euros of emergency lending.

Political opposition in Germany and IMF fiscal conservatism in Washington dictated that the rescue package had austerity strings attached: a tough series of public sector cuts designed to reassure international investors that the government can become creditworthy again.

The problem with that is the traditional response to runaway debt, devaluation, is not available because Greece's membership of the single-currency European Monetary System (EMS) ties it to the German powerhouse economy. If one EMS member wanted to devalue they would all have to do the same. And that would be against Germany's interests. This means the Greek government cannot stimulate economic growth by devaluing its currency, and nor can it cut interest rates, which would help, because these are decided by the European Central Bank in Frankfurt. Instead, ever deeper public sector cuts and more ferocious austerity are almost certain to deepen the Greek recession, reducing tax revenues and making it even harder to service the debts in future.

What many investors fear is that the only way out of this vicious circle is for Greece to walk away from its existing debts and try to go it alone – potentially triggering a wave of similar defaults in other indebted European countries, and jeopardising the euro itself. In the meantime, what many Greeks fear is that the IMF option is just going to prolong the agony – and drive the country to the brink of political as well as economic collapse.

What constitutes 'Sovereign Debt'
(this section uses UK economic conditions for its eaxamples)
Debt simply refers to the amount of money owed by the a government. This is the amount of unredeemed borrowing that has been built up over many years by many governments.

But use the word carefully. The most regularly quoted debt figure is actually the net debt of the UK; in other words, the total debt minus the government's liquid assets.

An easy way to compare debt levels across different countries is to express debt as a percentage of total economic output, or GDP, which is why you'll hear commentators regularly talk about the debt-to-GDP ratio. Obviously this has risen sharply since 2007. Beware though, GDP only measures money circulating around the economy. I buy £50 worth of goods from you, you replace your stock from the wholesalers and pay a repair bill with the £20 profit, the wholesale gives his warehouse man a £30 bonus and the handyman spends his £20 on new tools and my £50 has increased GDP by £150.

According to the Office for Budget Responsibility, the UK's debt will keep on rising for a number of years. So if anyone tries to tell you that UK debt (as the current government have recently) is falling, they are wrong. In the recent case the deficit is falling but that's a different thing.

The current budget deficit, or surplus, is the difference between the government's everyday expenses and its revenues; in other words, between what it spends and what it receives. In recent years, it has spent a lot more than it receives, so we are used to hearing about a budget deficit. The government thinks if they say it quickly we will be deceived into thinking deficit and debt are the same.

If a government spends less than it receives (stop laughing at the back), it would be running a budget surplus. This may seem a strange concept in today's economic climate, but between 1998 and 2001 we had four straight years of surplus. In fact, there was a surplus every year between 1947 and 1974.

Both the government and opposition are pledging to return the current budget to surplus in the next Parliament.

That seems straightforward. Problem is is, when politicians and commentators talk about the deficit, they are not actually talking about the budget deficit.

BorrowingBorrowing is... well, borrowing. Strictly speaking, borrowing and deficit (current budget) are not the same thing.

The two are linked, of course, as one covers the other, but the government doesn't just borrow money to pay back the deficit. It also borrows to invest.

The current budget covers everyday expenses - welfare payments, departmental costs etc. But the government also makes big investments, such as infrastructure projects, that are not included.

If the government is running a deficit, it may make investments on top of this, and will therefore need to borrow to cover both.

For example, in the calendar year 2007, the Labour government borrowed £37.7bn, of which £28.3bn was invested in big projects (the balance of £9.4bn represents the current budget deficit). Conversely, in 2013, the Conservative-led coalition borrowed £91.5bn, with just £23.7bn invested.

A neat, if rather simplistic, illustration of the different philosophies of the right and left in UK politics, some might say.

In the case of a surplus, the government may still need to borrow to cover its investments. This is why a current budget surplus does not automatically lead to a fall in overall debt, as borrowing to invest might be greater than the surplus. Equally, if government assets grow by more than the current budget deficit, then the deficit would not lead to an increase in overall debt.

Anyway, the important thing to remember is that, although there is a difference between the current budget deficit (or surplus) and government borrowing, for simplicity's sake commentators will usually quote borrowing figures when talking about the deficit. And you can see why, as they cover big infrastructure investment as well as everyday spending. After all, it is all borrowed money that needs to be paid back, and that adds to the overall pile of debt.

A recent agreement between the European Central Bank (ECB) and the central banks of the Eurozone member nations raises the prospect of EU taxpayers being forced to pay for more bailouts, German newspaper Die Welt reports.